History and Mechanism of Microfinance
Micro financing means small size loans. The origins of microfinancing can be traced to Europe. The late nineteenth century witnessed the boom of credit cooperatives to support the lower income groups through credit. The cooperatives grew to accommodate 1.4 million persons in Germany in 1912. These programs were then replicated in Ireland and Italy. The government of Madras in 1880, then under the imperial rule, introduced the programs to address poverty in India. . By 1912, over four hundred thousands Indians belonged to the new credit cooperatives. By 1946 their members exceeded 9 million.
The cooperatives during this time period grabbed global attention in the State of Bengal, now Bangladesh. In the early 1900’s, these programs were so popular in Bengal that the leading merchant of Boston, USA, stayed in India to learn the workings of cooperatives in order to replicate those homogenous programs in Boston later.
These programs were a standout amongst the most essential interventions in a developing country endeavors to reduce poverty. Recent years have seen a huge growth of the sector in terms of numbers and size of organizations, numbers of customers and provision of subsidized donor funding. A large proportion of MFIs include poverty reduction in their Mission, and donor funding is allocated to microfinance on this premise. At the most basic level there is a need to understand and improve the impact of MFIs as a key premise to successful poverty reduction.
Over time, MFIs has incorporated an extensive range and scope of their services (credit, savings, insurance, etc.) as we now understand that the poor and the extremely poor that has no access to traditional formal financial institutions oblige a variety of financial products.
Traditionally, microfinance was focused on providing a very standardized credit product. The poor, just like anyone else, need a diverse range of financial instruments to be able to build assets, stabilize consumption and bulwark themselves against perils. Therefore, we see a broadening of the concept of microfinance in the light of the fact that our current challenge is to discover the proficient and reliable methods of providing a richer menu of microfinance products.
The regular microfinance customers are low-income persons that do not have access to formal financial institutions. Microfinance clients are normally self-employed, often household-based entrepreneurs.
In rural areas: In rural areas, they are usually small farmers and others who are engaged in small income-generating activities such as food processing and petty trade In Urban areas: In urban areas, microfinance activities are more diverse and incorporate shopkeepers, service providers, artisans, street vendors, etc. Microfinance customers are poor and vulnerable non-poor who have a relatively stable source of income.
Access to conventional formal financial institutions, for many reasons, is inversely related to income: the poorer you are, the less likely that you have access. Then again, the chances are that, the poorer you are, the more expensive or onerous informal financial arrangements. Moreover, informal arrangements may not suitably meet certain financial service needs or may avoid you in any case. Individuals in this barred and under-served market segment are the customers of microfinance.
The poor does not have adequate collateral to secure the credit. As opposed to taking collateral, MFIs uses group's shared responsibility to ensure repayments. This banking technology is sometimes called "Solidarity Group" in the case of 2-10 people, and "Village Banking" in the case of 11-50 people. The group monitors and exerts peer pressure for repayments.
Target group is identified by historical data for less default ratio, such as women engaging in small trading activities. Credit analysis is made at the household level considering the cash flows of each economic activity.
The group may maintain an obligatory reserve funds to minimize the risk of default by one member. Sometimes, there is a Guarantee Fund created by obligatory share of the loan. In order to accommodate a substantial number of the poor people, MFIs impose relatively higher income thresholds or limit the maximum amount of loans relatively small. Different interest rates are applied to different loan amount, duration, risk level, personnel characteristics and repayment performance. Usually MFIs impose intensive supervision, using peer group meetings. Also MFIs offer incentives for the borrowers to repay through rebates and progressive lending. MFI staff is also rewarded according to the repayment ratio. Customers and MFI staff are given intensive training programs